The full extent of the damage caused by Hurricane Ian is still being tallied. The death toll—which now stands at 120—rises by the day. As those living in the storm’s path attempt to rebuild, they may now also have to deal with the downstream effects of a crisis in pristine, far-off boardrooms. According to a new analysis by Stonybrook Capital, Ian may be the single biggest insured loss ever, totaling an estimated $75 billion. The company warns that the effect on the insurance market could be “profound and widespread.”

For years, the insurance industry has devised increasingly complex ways to maintain a steady stream of profits. But as climate-fueled disasters keep mounting, that creativity may be reaching its limits. Policymakers too are running up against limits on their longtime strategy of passing the buck for climate recovery and resilience to a sector that was never meant to provide them.

About half of the residential mortgage market is backed by agencies regulated by the Federal Housing Finance Agency, including Fannie Mae and Freddie Mac. If you need to get a federally backed mortgage, then you need homeowners’ insurance. Those policies cover damages from wind and fires but not floods. Flood insurance is similarly mandatory for most mortgage borrowers in flood-prone areas, and subsidized by the National Flood Insurance Program, which reimburses losses up to $250,000 under the umbrella of the Federal Emergency Management Agency. That can leave serious gaps, particularly in high-cost and rapidly growing areas like Florida’s Western Coast. Enforcement on who takes out flood insurance is lax, and many areas where homeowners aren’t required to carry it have, in fact, been flooded. Those with coverage could still pay dearly to rebuild. Mortgage borrowers in Cape Coral and Fort Meyers, for instance, have an average of $316,499 in equity wrapped up in their homes.

Insurers themselves take out insurance to protect against massive losses. Typically those policies, known as reinsurance, are issued by companies based in Europe or on Wall Street like Munich Re or Swiss Re. But escalating costs amid an uptick of disasters has made insuring the insurers an increasingly expensive prospect.

In reaction to a string of destructive storms in 2004 and 2005, including Hurricane Katrina, reinsurers began to experiment with something known as insurance-linked securities, or ILS, including catastrophe bonds (“cat bonds”). Not unlike mortgage-backed securities, cat bonds bundle together reinsurance and insurance companies’ exposure to different forms of risk—like California fires and Florida hurricanes—into a financial product with its own risk portfolio. 

That risk is determined by complex, proprietary modeling that has grown up around the novel asset class. Zac Taylor, a professor at Delft University of Technology who studies climate risk and the insurance sector, writes that such modeling has “helped to transform amorphous climate uncertainties into exchangeable risk objects, into ‘just another asset class.’” If a single catastrophe rises above a certain predetermined damage threshold, then raised funds go back to the sponsor of the bond to pay out claims. If it doesn’t, then investors continue to collect interest. Essentially, cat bonds ask investors to place a well-informed bet on the weather. 

After the financial crisis, ILS products took off as institutional investors like hedge funds and pension funds went searching for reliable sources of yield that weren’t so directly tied to the rest of the economy. But financial markets will only shoulder so much risk. While the full effect of Ian on the ILS market remains to be seen, Stonybrook Capital’s report paints a bleak picture: “Many diversified Cat funds are now deep in the red for the year (if not earlier), and all will have ‘trapped capital’ again. Some will now report experience that is far below their investor representations in 5 of the last 7 years.” The ripple effects of that could be profound, leading to a dramatic rise in prices for policyholders. Making matters worse is the fact that the Federal Reserve is also hiking interest rates, potentially rendering cat bonds less attractive to institutional investors who can find better returns elsewhere.

Though it’s a critical lifeline to people rebuilding from climate-fueled disasters, the insurance industry isn’t preternaturally well equipped to weather rising seas and temperatures. Historically, insurance has protected against seemingly random and uncorrelated events, from car accidents to lightning strikes, kitchen fires, and burglary. “The problem with climate change is that now you have a systemic risk that’s getting worse. You don’t have a random pool where some people will be OK and some people won’t,” said Rachel Cleetus, policy director with the Climate and Energy program at the Union of Concerned Scientists. That assertion is backed by data: According to a recent report from the National Oceanic and Atmospheric Administration, the number of billion-dollar weather-related disasters per year is rising. In coastal states like Florida, Cleetus adds, “you find out that almost everybody is exposed.”


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